How is China reacting to Trump’s trade war?

The escalating trade tensions between the US and China has led to a significant strain on the trade relationship between the two countries, both of which rely heavily on each other. Despite some exemptions to mitigate the costs, and the ongoing negotiations for a potential deal which are taking place in Geneva, the tariffs are signs of the deteriorating relationship.This paper assesses the impact of US tariffs on China’s employment and GDP. We consider two scenarios: one where only China's exports to the US drop by 80%, leading to a potential decline in manufacturing employment by 6.4%, risking more than 6 million jobs; and another where exports to Southeast Asia to revert to their pre-trade-war value (in 2018) on top of the first scenario, employment exposure will rise to as many as 9 million jobs.Moving to the overall impact on China's GDP, imports are bound to fall along with exports but to a lesser extent since China’s domestic content of exports is only growing. Against such backdrop, one could expect a reduction in the contribution of external demand to GDP growth of 1.9 percentage points. Furthermore, the decline in exports will cause wage growth to decelerate and, thereby, consumption, whose contribution to GDP growth will fall by 0.4%. If we further add the loss in investment confidence, in line with the recent trend of decline, we expect a 0.2% reduction in the FAI’s contribution to China’s GDP growth rate. All of these factors together would bring China to 2.5% GDP growth in 2025, which is half of the government target.Absent a massive tariff rollback, China would need to deploy significant stimulus. However, China may opt for a gradual approach. It will phase in supports while monitoring negotiation progress, showing its resilience during the trade war to maintain a strong negotiation stance. The negotiations starting in Geneva this weekend is unlikely to change the overall picture since the US is bound to maintain its ultimate objective of decoupling from China. This is why China’s stimulus is a must if China wants to avoid shaving off half of its growth.  And yet, given that China needs to balance growth with other social objectives, one should not discard the possibility of a reduction of official growth target down the road.